Nexus Infrastructure (NEXS)

Rising from the rubble of the UK's house building industry

There are three activists I follow. The most famous being Peter Gyllenhammar, the Swedish investor whose rise is documented in the classic investment book Free Capital. I’ve tracked Peter Gyllenhammar’s investments for years. Not only because he is a private investor with an impressive track record, but because we tend to like similar ideas. Micro-caps with mature businesses that are hit by temporary problems.

When I started looking at the AIM listed Nexus Infrastructure, I couldn’t understand the attraction. Two higher growth segments (TriConnex and eSmart Networks) had recently been sold and the proceeds used to buy back ~80% of all Shares Outstanding. The remaining business, a civil engineering company called Tamdown, is loss-making, low-margin and cyclical. Recent results looked terrible and I struggled to find any obvious competitive advantages.

It’s only when I studied Tamdown’s long history that I began to see the current issues as temporary. As a business, Tamdown had been competing in the same industry for over 40 years, and prior to 2020 was consistently profitable in every year going back to 1995 (the oldest report I could find on Companies House). For a construction company, linked to the cyclical housebuilding industry, this was unusual. Tamdown had not only survived, but remained profitable, during all of the major housebuilding downturns over this period, including the 2008 financial crisis.

Before I get carried away, let me provide some background information. Tamdown is a Civil Engineering and construction company that focuses on the largest residential developments in the South East of England. It specialises on the initial stages of a building project - designing and constructing Earthworks, Drainage Systems, Highways and Foundations, which together represent roughly a quarter of the total development cost (excluding the price of land).

Examples of recent developments can be found on Tamdown’s website.

Tamdown’s customers are essentially the biggest residential house builders in the UK (see above). Two-thirds have worked with the company for over 5 years and it has three relationships that have lasted multiple decades (Vistry Group, Barratt Homes and Taylor Wimpey).

Contracts typically last around 12 months and Tamdown has historically won at least 1 in every 3 proposals (the YTD win-rate is 1 in 2.4). According to management, this high win-rate stems from Tamdown’s focus on multi-phase developments (currently representing ~75% of sales). These are the largest projects and so competition is reduced to a handful of firms that can provide similar services at scale. Multi-phase developments (on average) take around 8 years to complete and there’s a separate bidding process for each 12 month phase. Win-rates are particularly high because once the initial phase is won and the relationship established, house builders normally retain the same firm for the entire development.

Looking at the past few years, this period of low margins and unprofitability seem to be the result of three temporary factors. The first was rapidly rising inflation, which hit the business hard because all contracts are agreed upfront at a fixed price. The second was the bankruptcy of Ilke Homes in 2023, which resulted in lost sales and a one-off write-down in receivables. Neither issue is expected to persist.

More recently, it’s been the general slowdown in the housebuilding industry that’s dragged on profitability. Housing starts in England, which represents a decent proxy to the health of Tamdown’s Order Book, have been at multi-year lows. Similar to the initial COVID-19 shutdowns or the worst of the 2008/09 financial crisis.

Yet, there are tailwinds. Arguably, there’s pent-up demand as new houses being built within the UK have been consistently below the required level, which both major political parties agree is ~300,000 per year. There’s also increasing political will to improve the number of new houses being built. The recently elected Labour government has committed to building 1.5 million homes within the current parliament (or ~300,000 per year). So far, Labour have eased the planning process and introduced mandatory housing targets for all Councils in England.

There’s also signs of strengthening demand as interest rates stabilise and mortgage approval levels return to historical norms:

It’s still early days, but some of these tailwinds are feeding through into Tamdown’s most recent results. There’s been a pickup in the Order Book (defined as secured work yet to be carried out) from a low point of ~£46 million on 30th September 2023, to ~£52 million on 30th September 2024. There’s also been a normalisation of Gross Profit towards the historical average (and management’s target) of 15%. An important milestone, considering SG&A costs are almost entirely fixed.

Partly, these improvements can be attributed to the new management team. After the sale of TriConnex and eSmart Networks, the previous CEO Michel Morris handed over to the COO, Charles Sweeney. Perhaps of more significance is the new CFO, Dawn Hillman. She brings some continuity after being promoted from Finance Director of Tamdown, a role she’d held for over a decade.

The new board also introduced a welcome strategy focused on cost cutting and improving margins. Alongside this, management wants to diversify into less cyclical end markets such as UK Critical Infrastructure, which has longer contracts and provides much better revenue visibility. The recently acquired Coleman Construction represents the first step on this journey.

Major changes are also apparent on the shareholder register. Prior to the company’s IPO in 2017, Keith Breen and Michel Morris, were Co-Managing Directors and owned over 85% of all Shares Outstanding. Since then, both have been selling and only Michel Morris remains a material owner with ~9% of Shares Outstanding. The largest shareholder is now the aforementioned Peter Gyllenhammar, with ~28% of Shares Outstanding.

To value a cyclical company, I tend to use a mid-cycle multiple of earnings. Nexus Infrastructure has no Net Debt, and at 130 pence per share, the current Market Capitalisation (and Enterprise Value) is ~£12 million. Tangible Book Value is ~£30 million and I’d estimate mid-cycle (or normalised) Sales to be ~£100 million and Operating Profits to be ~£5 million.

Let’s assume that you believe, as I do, that the current issues are temporary and a return to normalised profitability is likely. At this point, Nexus Infrastructure would be earning almost half its current Market Capitalisation in profit every year. Even for a cyclical company, this seems wildly cheap!

But before we rush out and buy shares, I want to cover some of the risks. Most obviously, would be a continued slump in the wider housebuilding sector. Low profitability or further losses would be difficult to stomach, but ultimately I think Nexus would survive. It has a decent balance sheet with ~£8 million in cash (post acquisition) and no financial debt (although it does have a ~£10 million long-term lease liability on its offices).

The other main risk comes from customer concentration. Even though the majority are well-capitalised public companies, individually a single customer can reach almost ~20% of total sales. A related point concerns Overdue Receivables, which peaked at ~£13 million in 2020 and has only been reduced to ~£10 million as of 30th September 2023. Further write-downs are possible.

There’s lots to consider here and the obvious cyclicality makes this a tricky investment. But if housebuilding normalises within a reasonable time period, this will almost certainly be a home run! Considering the current tailwinds, both within the business and the wider housebuilding industry, I think Nexus Infrastructure is undervalued. Especially, for someone who's got the stomach to own this investment for the long-run.

Disclaimer. This article is for informational purposes only, and should not be seen as investment advice. Please do your own research before investing in any company mentioned.